Climate economics - costs and benefits

Policymakers and politicians rely on economics to guide decision making on the risks posed to society by climate change. Central to that task are economic models. They can be used to estimate the future costs of climate change impacts such as heatwaves, flooding and sea-level rise, alongside the economic benefits of preparing for them. Models also estimate the costs and benefits of measures that reduce greenhouse gas (GHG) emissions.

The future costs and benefits of climate change are uncertain and unevenly distributed. For example. the costs of dealing with the impacts of climate change fall disproportionately on developing countries, whilst the financial costs of cutting emissions to mitigate those impacts fall mostly to developed nations.

According to Morgan Stanley, climate-related disasters cost the world $650 billion from 2016-2018. The Organisation for Economic Co-operation and Development (OECD) puts the cost of achieving the UN’s Sustainable Development Goals, in a way compatible with Paris, at $6.9 trillion a year, to 2030. And a 2019 World Bank estimate suggests the necessary global infrastructure investment would cost $90 trillion by 2030.

Already, more variable weather has likely made crops more difficult to grow. A warming world could depress growth in agricultural yields up to 30% by 2050, affecting as many as 500 million small farms worldwide. Large coastal and delta cities are predicted to flood more frequently, incurring clean-up and, in some cases, moving costs.

Measures that help people adapt to these impacts also incur costs, but evidence shows that the future benefits of action overwhelmingly outweigh the future costs of inaction. The UK National Audit Office, for instance, estimates that for every £1 spent on protecting communities from flooding, around £9 in property damages and wider impacts can be avoided.

It has been clear since Nicholas Stern’s landmark 2006 review of the economics of climate change that the costs of not acting to tackle climate change are much higher than the costs of taking action. And whilst the costs of projected impacts have only grown since then, the costs of many of the technologies for tackling climate change have fallen considerably.

Some climate impacts are inevitable because GHGs already in the atmosphere will affect the climate for decades, even centuries to come. Governments therefore have a choice of whether or not to prepare for those impacts (adapt) alongside cutting emissions (mitigating) to avoid further impacts.

Policies to combat climate change may also affect growth and prosperity. Despite wind and solar photovoltaics (PV) now being cheaper than fossil fuels in most countries, some forms of low-carbon energy are still more expensive, such as hydrogen. But climate policies that subsidise or support emerging low-carbon technology can prove cost effective in the long run, for example by making energy cheaper, avoiding climate impacts and producing co-benefits, such as reducing the health impacts of air pollution.

The Global Commission on the Economy and Climate concluded that transitioning to a low-carbon, sustainable growth path could deliver a direct economic windfall of $26 trillion and create over 65 million new jobs by 2030 compared with business-as-usual. The Energy Transitions Commission has even shown that decarbonising ‘hard-to-abate’ sectors — such as steel, aluminium, cement and heavy transport — is technically feasible by 2050 with technology that already exists. The total cost to the global economy would be less than 0.5% of GDP by mid-century — and could be reduced even further.

Worldwide employment in renewable energy was estimated at 12 million in 2020, according to the International Renewable Energy Agency - up from 11.5 million in 2019

Economists evaluate the impacts of climate change and policies with state-of-the-art computer models called Integrated Assessment Models (IAMs).

IAMs include projections of the physical aspects of climate change, such as how much sea-levels rise. They also include projections of factors such as economic growth, global energy and land use, demographic change and technological progress.

Models essentially produce cost-benefit analyses of climate policies. But details about the climate system’s response to emissions and society’s progress are deeply uncertain. Where data is scarce, modelling becomes even more difficult. So model projections are inevitably sensitive to various assumptions.

The best models include a way of accounting for the profound uncertainties that exist. But some may underrate certain risks, such as the possible collapse of the polar ice sheets or ‘compound risks’, such as pest and disease outbreaks. They may also fail to capture the economic co-benefits of reducing emissions or developing low-carbon technologies. For example, limiting warming to 1.5°C rather than 2°C by 2060 has been estimated to result in co-benefits of 0.5–0.6% of global GDP, owing mostly to reductions in air pollution.

A further limit is that models may not reflect certain ethical aspects of climate change. For example, allowing high emissions in one country may have damaging effects in others. The impacts of emissions today also fall most significantly on future generations.

Economists deal with the former by applying ‘equity weights’ that estimate the impact of GHG emissions on different countries, and the latter by applying a ‘discount rate’. A discount rate effectively gives less weight to events the further they occur in the future, due in large to the assumption future societies will be wealthier than they are today. The precise discount rate to use has been a long-standing point of contention for climate economists.

The impacts of climate change over the next few decades will largely be driven by greenhouse gases already in the atmosphere. The UN Environment Programme estimated in 2016 that the global cost of adapting to these climate impacts is expected to grow to $140-300 billion per year by 2030 and $280-500 billion per year by 2050.

A recent focus of IAMs has been to estimate if the world would be better off limiting global warming to the more ambitious Paris Agreement target of 1.5°C compared with 2°C. The Intergovernmental Panel on Climate Change (IPCC) showed that the risks to global aggregate economic growth due to climate impacts are projected to be lower by 2100 at 1.5°C than at 2°C. In fact, the estimated costs of damages from warming in 2100 for 1.5°C and 2°C were $54 trillion and $69 trillion, respectively, relative to 1961–1990.

Certain climate impacts, such as loss of human lives, biodiversity loss, or loss of culture or identity, are difficult to value in monetary terms, so are often omitted from projections.

The other side of the climate economics question concerns the costs and benefits of reducing GHG emissions. According to the International Renewable Energy Agency, electricity generated by onshore wind and solar PV technologies is now cheaper than from any fossil fuel source. This trend is almost certain to continue: renewable power capacity is forecast to rise more than 60% on 2020 levels, by 2026, to more than 4,800 GW – which is equivalent to the total global power capacity of fossil fuels and nuclear combined.

Still, there is no global price for emitting carbon dioxide, a result of political unwillingness to implement one, and the difficulty of locking in a future trajectory that investors have confidence in. The IMF estimates the implicit global subsidy from undercharging for energy supply costs (8%) and for its environmental costs and foregone consumption taxes (92%) in 2020 was as much as $5.9 trillion, or 6.8% of global GDP - expected to rise to 7.4% of GDP in 2025.

Meanwhile, some crucial decarbonisation technologies such as battery storage are still considered expensive, and carbon capture and storage (CCS) technology is not yet commercially viable. But technologies such as lithium-ion batteries and electric-produced hydrogen are ‘poised for rapid take-off’, just as solar PV and wind power technologies were a decade ago.